8 Red Flags to Avoid when Buying a Franchise
Make sure to check for these 8 red flags before pulling the trigger on that franchise.
Franchising is a great way for a new entrepreneur to test the waters of small business ownership. While starting a business of your very own is appealing, franchises come with many great benefits, including a built-in and proven business plan, a support network and a tried and true product or service. The franchise sector in the United States is massive, with around 782,000 franchises currently in operation and an economic output of close to $890 billion! The franchise industry accounts for 8.8 million direct jobs and due to a wide variety of sector within the industry, franchises are responsible for 50% of all retail sales in America.
No matter what industry you come from or where you are headed, there is a franchising opportunity for you. Franchises exist in virtually every industry from food manufacturing to accounting and the franchise sector is only expecting to expand. A new franchise business opens every 8 minutes in America and experts predict around 5.1% growth for this year. But before making your final decision, you’ll need to do some research. There are many pros and cons to franchising, and researching ROI, start-up costs, margins and contractual terms can help you determine where the right fit is. While there are some fantastic franchise opportunities out there, there are also some shady businesses too. To ensure that you don’t find yourself in a business situation you are regretting, keep an eye out for these red flags during your search.
Missing, Incomplete or Delayed Franchise Disclosure Document. The Franchise Disclosure Document discloses extensive information about the franchise and the franchisor that allows the potential buyer to make a more informed decision. If a franchisor delays getting this document to you or pieces are missing or incomplete, there is something they do not want you to see. This document is required for a potential buyer to make a fully educated decision and complete due diligence; if something is missing, let this serve as a major warning. Here is a full outline of what should be included in the Franchise Disclosure Document.
Litigation History. Finding out the litigation history of a potential franchisor is critical, not only because it gives you insight into the character of the officers and the franchise’s history, but also shows you any lawsuits made against franchisees. Litigation history is one of the most important parts of the Franchise Disclosure Document but you should also do some research of your own. A lengthy track record of lawsuits or convictions will tell you all you need to know about entering a business agreement with a franchise.
Poor Franchisor-Franchisee Relationship. During the due diligence process, you should have the chance to speak with current franchisees – take this time to find out about the franchisee-franchisor relationship. The most telling way to find out how the nature of the relationship is to speak to the franchisees that the franchisors do not recommend. Find out about the support system and if the model works. The franchisor will probably take an interest in this type of research and anything negative they say about their franchisees should be a big red flag to you. Any blaming of the franchisees or negative speak doesn’t bode well for a future with this franchise.
Inconsistent Business Model. If anything, the business model offered by a franchisor should be tried and true. If you find that the officers of the company are constantly tinkering with the model that means something – it doesn’t work! A franchise’s business model should be timeless and tightly linked to the values of the company; if it’s ever-changing, it’s because they haven’t perfected the model. Offering a proven business model is one of the essential benefits of buying into a franchise; if the model doesn’t work, you can find another franchise that will.
Pressure, Speed & Discounts in the Pre-Sale Process. If a franchisor is applying pressure or trying to hasten the pre-sale process, think about that. Finding a franchisee to represent your brand shouldn’t be about finding just any one – it should be the right fit, and a franchisor that is rushing the process along seems more desperate than strategic. While it may be hard to ignore the pressure, taking your time during due diligence will only help you in the end or maybe turn you off the franchise altogether. The same sentiment goes for discounts. Everyone loves a deal and while it may feel like this is a great offer, the franchisor should not be trying to entice everyone into buying in – they should be looking for the right fit.
Lack of Support. When you’re talking to the current franchisees, find out about the support system offered by the franchisor. A support system offered by a corporate office as well as a franchisee network is one of the top reasons people choose to open a franchise; without this, you’re basically just starting a business like anyone else. As mentioned before, don’t just talk to the top franchisees that you are referred to by the franchisor; seek out mid-range franchisees and find out about the support they have gotten from the franchisor, especially during troubled times. Our economy is always changing and signing on with a franchisor who will be there through thick and thin is crucial when choosing a franchise.
Financial Instability. All businesses go through up’s and down’s and analyzing a potential franchise’s financial records is a necessary part of your due diligence. The Franchise Disclosure Document should provide you with net profits, geographic relevance, franchisee backgrounds, average incomes, gross sales, financial statements, royalty information and bankruptcy history. Using this information, you should be able to determine how the franchise is doing financially and what the future looks like. Past behavior is an excellent predicator of future behavior and if you reveal anything sketchy during your research, do not put yourself at risk by signing on with this franchisor.
Longevity but few franchises. If the franchise itself has been around for a while but they have fewer franchises than expected, this is something to take note of. Not having many franchises in the face of a seemingly perfect offering means there is something else at play that is causing franchisees to bail. Oftentimes, the franchisor will place a gag order on past franchisees to ensure they are not able to tarnish their name or warn potential franchisees. A quick internet search may reveal a few things about past franchisees and give you some insight as to how things are handled when a franchisee becomes unhappy. Depending on the nature of the business, this could vary but not having many franchises in combination with any of these other red flags is definitely something to be wary of.
Many successful entrepreneurs begin their careers by buying into a franchise. A proven business model, network of franchisees, and a time-tested product can majorly assist in the road to owning a business. But no matter how great a franchise appears to be, arm yourself with as much information as possible so that you can make an educated decision. Like any major milestone, purchasing a franchise is life changing and before locking yourself in, do your homework to make sure the franchisor is supportive, stable and successful. Many of our intermediaries (myself included) have owned franchises and we have also helped dozens of small business owners buy and sell franchises of their very own. You can also find out what franchised businesses we currently have up for sale. We applaud you for taking the first steps to making your dream of owning a business a reality and hope that this article can help you find the right franchising fit for you.